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Trading for the Future: Signaling in Permit Markets

  • Harstad, Bård

    ()

    (Kellogg School of Management, Northwestern University)

  • Eskeland, Gunnar S.

    ()

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

Permits markets are celebrated as a policy instrument since they allow (i) firms to equalize marginal costs through trade and (ii) the regulator to distribute the burden in a politically desirable way. These two concerns, however, may conflict in a dynamic setting. Anticipating the regulator's future desire to give more permits to firms that appear to need them, firms purchase permits to signal their need. This raises the price above marginal costs and the market becomes inefficient. If the social cost of pollution is high and the government intervenes frequently in the market, the distortions are greater than the gains from trade and non-tradable permits are better. The analysis helps to understand permit markets and how they should be designed.

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Paper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2010/2.

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Length: 47 pages
Date of creation: 26 Mar 2010
Date of revision:
Handle: RePEc:hhs:nhhfms:2010_002
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